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Unformatted text preview: 00 = $256.57 NPV = $2,492.11 - $2,000 = $492.11 Choose project beta. 6.15 Although the profitability index is higher for project B than for project A, the NPV is the increase in the value of the company that will occur if a particular project is undertaken. Thus, the project with the higher NPV should be chosen because it increases the value of the firm the most. Only in the case of capital rationing could the pension fund manager be correct. 6.16 a. b. c. d. PIA = ($70,000 / 1.12 + $70,000 / 1.122) / $100,000 = 1.183 PIB = ($130,000 / 1.12 + $130,000 / 1.122) / $200,000 = 1.099 PIC = ($75,000 / 1.12 + $60,000 / 1.122) / $100,000 = 1.148 NPVA = -$100,000 + $118,303.57 = $18,303.57 NPVB = -$200,000 + $219,706.63 = $19,706.63 NPVC = -$100,000 + $114,795.92 = $14,795.92 Accept all three projects because PIs of all the three projects are greater than one. Based on the PI rule, project C can be eliminated because its PI is less than the one of project A, while both have the same amount of the investment. We can compute the PI of the incremental cash flows between the two projects, Project C0 C1 C2 PI B-A -$100,000 $60,000 $60,000 1.014 e. 6.17 a. b. We should take project B since the PI of the incremental cash flows is greater than one. Project B has the highest NPV, while A has the next highest NPV. Take both projects A and B. The payback period is the time it takes to recoup the initial investment of a project. Accept any project that has a payback period that is equal to or shorter than the company's standard payback period. Reject all other projects. The average accounting return (AAR) is defined as Average project earnings Average book value of the investment. Accept projects for which the AAR is equal to or greater than the firm's standard. Reject all other projects. The internal rate of return (IRR) is the discount rate which makes the net present value (NPV) of the project zero. The accept / reject criteria is: c. B-68 Answers to End-of-Chapter Problems If C0 < 0 and all future cash flows are positive, accept the project if IRR discount rate. If C0 < 0 and all future cash fl...
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This note was uploaded on 05/07/2010 for the course FIN 302 taught by Professor Corporationfinance during the Spring '10 term at Uni Potsdam.
- Spring '10